The relationship between retail and private equity has been a fraught one for years. But the pandemic has brought on a whole new set of issues.
Consumer spending cratered. Social distancing guidelines forced stores to limit foot traffic. And many shoppers have remained reluctant to leave the house. For companies already coping with a shift toward ecommerce—and, in many cases, piles of buyout-fueled debt—it's proving a recipe for disaster.
Two dozen US-based retailers backed by private equity firms have filed for bankruptcy protection so far this year, according to PitchBook data, including shopping mall staples such as J. Crew and Neiman Marcus. That's already the highest annual total since 2015.
And the list will likely grow even longer before the year is out: Retail Dive, which closely tracks the industry, predicts that 17 retailers are at high risk of filing for bankruptcy in the next 12 months.
"I think that it's just going to be a radical shift in terms of the retail landscape," said Jill Rowe, a partner at law firm Venable who focuses on real estate law within the retail space. "Some folks are going to survive and thrive … and some folks are just going to shut their doors."
But some PE firms have continued to pursue opportunistic investments in retail, searching for those targets that may, as Rowe says, "survive and thrive" in this new reality. There just aren't as many attractive targets as there used to be—one reason deal count in the sector is on pace to drop some 33% in 2020, according to PitchBook data.
Why has private equity remained active despite the retail industry's many headwinds? In some ways, it’s never been a better time to buy in, with low interest rates and plummeting valuations leading to deal terms that still come with the potential for profit while minimizing risk.
"Think about the cost of leverage right now. Money is basically free," said Jaime Katz, a retail analyst at Morningstar. "The assets are pretty much free because they're not worth anything to anybody."
The busiest investors in recent months have been firms that already have a long history in the retail space.
Sycamore Partners has made a habit of investing in retailers on the back end of bankruptcy, with a current portfolio that includes names such as Hot Topic, The Limited and Staples. In late September, Bloomberg reported that the firm had made a preliminary offer to buy the Ann Taylor, Lane Bryant and Loft brands from Ascena Retail Group, which filed for Chapter 11 bankruptcy protection in July after sales plummeted due to COVID-19.
Brookfield Asset Management and Simon Property Group, both of whom control large portfolios of retail-related real estate, have also stayed active. In February, the two teamed up with Authentic Brands Group to acquire Forever 21 out of bankruptcy. In August, Simon again co-invested with Authentic Brands on a $325 million agreement to purchase the bankrupt Brooks Brothers brand. And in September, Brookfield and Simon agreed to pay $1.75 billion for the retail and operating assets of JC Penney.
Some of the retailers that have gone under in 2020 were weighed down by debt that left them vulnerable to declining revenue and loans coming due. Others have been stymied by massive overhead real estate costs. And in the pandemic, there are few immediate options for repurposing former brick-and-mortar locations.
Ecommerce, though, is booming, a fortuitous development for firms such as Blackstone that have built up significant portfolios of ecommerce real estate in recent years. Last year, the firm struck an $18.7 billion deal to acquire 179 million square feet of ecommerce warehouse assets from GLP. Blackstone made a similar bet this March, scooping up another 22 warehouses and logistics sites in the UK from Clearbell Capital for £120 million (about $157 million today).
Some firms have turned to PIPE deals rather than buyouts to gain exposure to the retail space. And there is already example of the move paying off. In April, Great Hill Partners and Charlesbank Capital Partners purchased $535 million in convertible notes from online home decor company Wayfair. The company's stock has nearly quadrupled, pushing to around $300 per share.
It's the prospect of profits like that one that will continue to draw private equity interest, with the retail industry's ongoing struggles creating attractive opportunities to buy low.
"I suspect there will probably be pretty favorable terms over the next year, because a lot of these retailers are just distraught, and they need to get out of whatever they're in and it doesn't matter at what cost," Katz said. "They just don't want the burden anymore."